Capital Market

Introduction to the Capital Market

The capital market is the segment of the financial market where long-term securities, such as stocks (equity shares), bonds, and debentures, are bought and sold. Unlike the money market, which focuses on short-term instruments, the capital market provides a platform for long-term investments that contribute to economic growth and capital formation.

In India, the capital market is primarily regulated by the Securities and Exchange Board of India (SEBI). It plays a crucial role in mobilizing savings from individuals and institutions and channeling them into productive investments.

Structure of the Capital Market in India

The capital market in India is broadly divided into two main components:

1. Primary Market (New Issue Market)
2. Secondary Market (Stock Market)

1. Primary Market (New Issue Market)

• Definition: The primary market, also known as the new issue market, is where companies issue new securities (shares, bonds, or debentures) to raise capital directly from investors.
• Function: It enables businesses to acquire funds for expansion, modernization, new projects, and other long-term investments.
• Investors: Investors in the primary market purchase securities directly from the issuing company.
• Goal: Directing cash flow from the surplus sector to the deficit sectors such as the government and the corporate sector.

Types of Issues in the Primary Market:

1. Initial Public Offering (IPO):
   • Definition: The first time a company offers its shares to the public to raise capital.
   • Significance: Marks a company's transition from private to public ownership.
   • Listing: After a successful IPO, the company's shares are listed on stock exchanges like the BSE (Bombay Stock Exchange) and NSE (National Stock Exchange), allowing them to be traded in the secondary market.
2. Follow-on Public Offering (FPO):
   • Definition: When an already listed company issues additional shares to raise more funds.
   • Purpose: Can be used for various purposes, such as debt reduction, acquisitions, or expansion of operations.
3. Rights Issue:
   • Definition: Companies offer new shares to existing shareholders at a discounted price, proportional to their existing shareholding.
   • Purpose: Allows companies to raise capital while giving existing shareholders the opportunity to maintain their ownership stake.
4. Private Placement:
   • Definition: Securities are sold directly to a select group of institutional investors or high-net-worth individuals instead of the general public.
   • Advantages: Faster and less expensive than a public offering.
5. Qualified Institutional Placement (QIP):
   • Definition: Companies issue securities exclusively to qualified institutional buyers (QIBs) to raise capital efficiently.
   • Purpose: A quicker and less cumbersome method compared to other forms of public offerings.

2. Secondary Market (Stock Market)

• Definition: The secondary market, often referred to as the stock market, is where existing securities are traded among investors after they have been initially issued in the primary market.
• Function: Stock exchanges, such as the BSE and NSE, facilitate the buying and selling of shares, ensuring liquidity and enabling price discovery.
• Role: Facilitates liquidity by offering investors a way to buy or sell financial assets. Many profitable projects require long-term finance and investment which means locking up funds for a long period.
• Advantage: It is the presence of the liquid secondary market that attracts investors because it ensures a quick exit without heavy losses or costs.

Key Functions of the Secondary Market:

1. Liquidity:
   • Investors can easily sell their securities whenever they want, converting them into cash quickly.
   • This liquidity makes long-term investments more attractive.
2. Price Discovery:
   • Stock prices fluctuate based on market conditions, company performance, investor sentiment, and macroeconomic factors.
   • This continuous trading helps determine the fair value of securities.
3. Risk Management:
   • Investors can hedge against potential losses using derivative products like futures and options.

Participants in the Secondary Market:

1. Retail Investors:
   • Individual investors who buy and sell stocks for personal investment.
   • Participate directly or through brokers.
2. Institutional Investors:
   • Entities that invest on behalf of others, including mutual funds, insurance companies, pension funds, and foreign institutional investors (FIIs).
   • Have a significant impact on market trends due to the large volumes they trade.
3. Stock Brokers:
   • Registered intermediaries who facilitate trading for investors.
   • Provide investment advice and execute trades on behalf of their clients.
4. Market Regulators:
   • SEBI ensures fair trading practices, protects investor interests, and maintains market integrity.

Types of Capital Market Instruments:

1. Equity Shares (Stocks):
   • Definition: Represent ownership in a company.
   • Rights: Shareholders may receive dividends (a portion of the company's profits) and have voting rights in company decisions.
2. Preference Shares:
   • Definition: A hybrid between equity and debt.
   • Features: Investors receive fixed dividends before equity shareholders and have limited voting rights.
3. Debentures and Bonds:
   • Debentures: Long-term debt instruments issued by companies without collateral, promising to pay a fixed rate of interest.
   • Bonds: Fixed-income securities issued by corporations or governments to raise capital.
4. Derivatives (Futures & Options):
   • Definition: Financial contracts derived from underlying assets like stocks, commodities, or interest rates.
   • Purpose: Used for speculation (profiting from price movements) and hedging (reducing risk).
5. Mutual Funds:
   • Definition: A pooled investment vehicle managed by professional fund managers.
   • Investment Strategy: Investors can buy units in equity, debt, or hybrid funds, depending on their risk tolerance and investment goals.
6. Exchange-Traded Funds (ETFs):
   • Definition: Marketable securities that track an index, commodity, or basket of assets and are traded like stocks on an exchange.
   • Advantages: Offer diversification and liquidity.
   • Example: Bharat Bond ETF

Role and Importance of the Capital Market:

1. Mobilization of Savings:

   • Encourages individuals and institutions to invest their savings into productive avenues, promoting economic growth.
   • Encourage broader ownership of productive assets.

2. Capital Formation:

   • Facilitates businesses in raising long-term funds for expansion, infrastructure development, and innovation.
   • Provides risk capital in the form of equity or quasi-equity to entrepreneurs.

3. Wealth Creation:

   • Provides investors with opportunities for wealth accumulation through capital appreciation (increase in asset value) and dividends.

4. Liquidity and Market Efficiency:

   • Investors can easily buy or sell securities, ensuring a vibrant and dynamic market.
   • Lower the costs of transactions and information.

5. Economic Growth:

   • Funds raised in the capital market are used for industrial expansion, job creation, and overall economic development.
   • Improve the efficiency of capital allocation through a competitive pricing mechanism.

6. Risk Management:

   • Derivatives and other financial instruments help investors manage investment risks effectively.
   • Provide insurance against market risk or price risk through derivative trading and default risk through investment protection fund.

7. Information Dissemination:

   • Disseminate information efficiently for enabling participants to develop an informed opinion about investment, disinvestment, reinvestment, or holding a particular financial asset.

8. Quick Valuation:

   • Enable quick valuation of financial instruments—both equity and debt.

9. Wider participation:

   • Enable wider participation by enhancing the width of the market by encouraging participation through networking institutions and associating individuals.

10. Operational efficiency:

    • Provide operational efficiency through
    • simplified transaction procedures;
    • lowering settlement timings; and
    • lowering transaction costs.

11. Integration:

    • Develop integration among
    • real and financial sectors;
    • equity and debt instruments;
    • long-term and short-term funds;
    • long-term and short-term interest costs;
    • private and government sectors; and
    • domestic and external funds.

12. Efficient Flow of Funds:

    • Direct the flow of funds into efficient channels through investment, disinvestment, and reinvestment.

Regulation of the Capital Market in India:

The capital market is regulated by various institutions to ensure fairness, transparency, and investor protection.

1. Securities and Exchange Board of India (SEBI):
   • Established in 1988 and given statutory powers in 1992, SEBI is the primary regulator for the securities market.
   • Functions of SEBI:
     • Protects investor interests.
     • Regulates stock exchanges and market participants.
     • Prevents fraudulent trading practices.
     • Promotes and regulates the development of the securities market.
2. Reserve Bank of India (RBI):
   • Regulates bond markets, foreign exchange markets, and banking institutions, influencing the overall financial system.
3. Ministry of Finance:
   • Oversees financial sector reforms and economic policies related to capital markets.
4. Stock Exchanges (BSE & NSE):
   • Facilitate trading, maintain market integrity, and enforce listing regulations to ensure orderly and fair trading.

Recent Developments in the Indian Capital Market:

1. Introduction of Stock Market Indices:
   • NIFTY 50 and SENSEX act as key indicators of market performance, providing benchmarks for investors.
2. Online Trading and Digitalization:
   • The rise of electronic trading platforms has increased market efficiency, accessibility, and transparency.
3. Regulatory Reforms:
   • SEBI has implemented stricter corporate governance norms and insider trading regulations to enhance investor protection.
4. Increase in Foreign Investments:
   • Foreign institutional investors (FIIs) and foreign direct investment (FDI) have contributed significantly to capital market growth.
5. Mutual Fund and ETF Boom:
   • Rising popularity of systematic investment plans (SIPs) and passive investment strategies has fueled the growth of the mutual fund industry.
6. Growth in Derivatives Market:
   • Expansion of futures and options trading has enhanced risk management strategies and provided opportunities for speculation.
7. Government Initiatives:
   • Launch of Bharat Bond ETF and disinvestment in public sector enterprises have contributed to market development and investor participation.
8. Capital market scams:
   • Harshad Mehta Scam: Manipulation of stocks led to a major market crash
   • Ketan Parekh Scam: Similar manipulation techniques affected several stocks.

Conclusion:

The capital market is a vital engine for economic development, facilitating long-term investment, ensuring liquidity, and promoting financial stability. With robust regulatory mechanisms, increasing investor participation, and ongoing technological advancements, India's capital market is poised for continued growth and greater integration with the global financial system. It is essential for economic growth and development